STC Series 66 Chapter 10 Test

A client and his wife purchased their home for $300,000. They have occupied their home for the last 26 years and have made $80,000 of improvements over the years. The home was recently put on the market for $800,000, but eventually sold for $770,000. Upon sale, the taxable capital gains would be how much?

$0 Upon the sale of a primary residence, a portion of any capital gains are excluded from taxation. If filing a single tax return, the first $250,000 of gains from the sale are excluded. If filing a joint tax return, the first $500,000 in gains are excluded. In general, to qualify for the exclusion, both the ownership test and the use test must be met. For example, five years prior to the sale of the home you must have occupied the home as your primary residence for a minimum period of two years.

Under ERISA, all the following are prohibited between the plan and parties of interest, EXCEPT:

Charging the plan an advisory fee All choices are strictly prohibited under Rule 404(c), except charging an advisory fee for services rendered to the plan.

Eileen has set up 529 plans for each of her grandchildren. What's the most that Eileen may contribute to each child's plan without incurring gift taxes?

$15,000 annually or $75,000 at one time Eileen may take advantage of the annual gift tax exclusion and contribute $15,000 per year to each of her grandchildren's 529 plans. Alternatively, she may choose to aggregate five years' worth of contributions into one large $75,000 contribution (5 x $15,000). If Eileen chooses to contribute $75,000 at one time, she cannot make any further contributions for five years without incurring gift taxes.

Jonah has recently retired at age 65. He is receiving a large lump-sum retirement payout from his former employer. Although he has only a small investment portfolio, he has accumulated savings that would cover six months of expenses. Which of the following combinations would be an appropriate allocation of Jonah's lump sum in an investment portfolio if his primary interest is income and his secondary interest is growth for inflation protection?

85% bonds, 15% equities While a portfolio that consists of 75% equities (25% cash and 75% equities) might be too volatile for a 65-year-old retiree, increased life expectancies have made some exposure to equities justifiable for such investors. Since equities provide much more inflation protection than bonds or cash (money-market investments), a small portion in stocks would generally be suitable. Based on the fact that this investor already has a six-month liquidity cushion in the form of savings, a large additional allocation to cash (either 100%, 50%, or 25%) may not provide enough income or inflation protection in the long run.

An advantage of a Coverdell Education Savings Account versus a 529 plan is:

A custodian has greater control over the investments With a Coverdell Education Savings Account, the custodian has greater control of the selection of investments (i.e., individual stocks, bonds, or mutual funds). There is a maximum contribution of $2,000 per year in a Coverdell. In a 529 plan, an investment is made in the state plan without the benefactor's input. Depending on the state, a 529 plan may allow a substantially larger contribution (exceeding $200,000 in some states). Both plans offer tax-free growth if the funds are used for qualified educational expenses. Funds in a Coverdell Education Savings Account (ESA) must be used within 30 days of reaching the age of 30. There is no specific age requirement for funds to be withdrawn from a 529 plan.

A married couple received $50,000 of cash as a wedding gift and intend to use the money as a down payment on a new home. They anticipate closing on the new home within six months. Which of the following investments is the MOST suitable?

A money-market mutual fund Since a money-market mutual fund is a very conservative and liquid investment, it's the best choices for this couple. A stock portfolio and ETF that's based on an index will expose the couple to market risk and are therefore unsuitable due to their short time horizon and capital preservation need. A bank-insured CD is conservative, but it's not liquid. With the CD, the couple would be required to redeem it early and be subject to a penalty. The type of CD that's liquid is a negotiable (marketable) CD since it can be bought and/or sold in the secondary market. However, negotiable CDs have a minimum denomination of $100,000, but often trade in $1 million denominations.

What are the advantages of a limited liability company (LLC) compared to an S Corporation?

A simpler managerial structure Owners of S Corporations and limited liability companies have limited liability. Both entities also have a flow-through tax structure. Income, capital gains, and capital losses are passed directly on to the investors and reported on their personal income tax returns. Neither entity pays federal corporate taxes on income earned. The advantage of a limited liability company is that its managerial structure is much simpler. There is no need for a board of directors or annual meetings or the other formalities of a corporation. However, unlike an S Corporation that has continuity of life, LLCs are dissolved after an event (e.g., owner dies) or a specific period passes.

The benefit of creating an irrevocable trust is that:

Assets will be excluded from the donor's estate In an irrevocable trust, the donor typically gives up all claims to assets that are placed in the trust. Also, assets in this type of trust are typically not included in the donor's estate. This reduction of assets will reduce any potential estate taxes that are payable by the donor's estate. Losing control of the assets is not a benefit to the donor, it is a drawback.

Which of the following is a characteristic of a Money Purchase Plan?

Employers must make mandatory contributions A Money Purchase Plan is a type of defined contribution plan to which an employer makes mandatory contributions, regardless of the company's profitability. For tax purposes, the employer is able to deduct the contributions.

All of the following choices are typical characteristics of a 401(k) plan, EXCEPT

Employers must match employee contributions In a 401(k) plan, an employee can usually make a pretax contribution to the plan and reduce taxable income. Employee contributions and growth in the account are tax-deferred. Employers are not required to match contributions, but may do so.

Harold has established a revocable trust. His son Stanley is the trustee and his daughter Dora and her children are the beneficiaries. The income is currently taxable to:

Harold Since this is a revocable trust, all the income produced by the trust must be included in Harold's (the grantor's) tax returns. The trust income would not normally be taxable to the trustee unless the trustee is also the grantor or one of the beneficiaries. Note, however, that the trustee would be responsible for making certain that the proper tax payments were made. If the trust is irrevocable, then the income is generally taxed to the trust or the beneficiaries.

A group of investors are forming a start-up company. The business will have approximately five investors. The investors want the most tax efficient business structure and to avoid paying taxes twice on company profits. Which business structure would allow them to protect their personal assets and also avoid double taxation? An S Corporation A C Corporation A limited liability company A closed corporation

I and III only S Corporations and limited liability companies (LLCs) are flow-through entities. Therefore, profits are passed through to the owners and reported on their individual tax returns. C Corporations, however, are subject to two levels of taxation, since they are considered separate entities for tax purposes. They must pay corporate income taxes and their shareholders must also pay individual income taxes on dividends that they receive. Closed corporations (also termed privately held corporations) are companies whose shares do not trade publicly. A closed corporation could be organized as either an S Corporation or a C Corporation. (Note, however, that S Corporations are almost always closed corporations since they may only have a maximum of 100 shareholders.)

For federal tax purposes, which TWO of the following are NOT included in gross income? Municipal bond interest Salary Bonuses Alimony payments received

I and IV Municipal bond interest and alimony payments received are excluded from a person's gross income for federal taxes. Alimony is non-deductible for the payer and non-taxable for the recipient. However, both bonuses and salaries are included in gross income and are taxable.

Under ERISA, the Investment Policy Statement of a qualified plan: Defines the roles of the parties involved in the management of the plan Identifies specific asset classes to be offered in the plan Lists the criteria for the selection and performance requirements for each investment option Requires the fiduciary of the plan to be registered as an IA with the state Administrator

I, II, and III only The Investment Policy Statement of a qualified plan does not address the registration requirements or status of the fiduciary. However, under the Uniform Securities Act, an IA has fiduciary responsibility and is exempt from state registration if the plan's assets are at least $1 million and the IA has no place of business in the state.

When meeting with a potential customer for the very first time, which of the following would be a reasonable course of action? Prior to the meeting, informing the client to bring additional financial information. If necessary, an IAR may inform the client that he may not know the answer to one of her questions, but will find out and respond within a reasonable period. Inform the client that she needs to increase her risk tolerance to obtain her goals. Discuss the customer's current financial situation and her goals for retirement.

I, II, and IV only When meeting with a potential customer, it would not be reasonable to tell her that she needs to change her risk tolerance. A client may increase the future value of a portfolio by saving more money or by allowing her money to compound over a longer period. It is often considered inappropriate to encourage a client to assume risk beyond her comfort level.

The Big Brain Inc. Defined Benefit Retirement Plan maintains a written statement for the plan's fiduciaries that provides them with information concerning various categories of investments and guidance concerning investment decisions. The common name for this document is the:

Investment policy statement Every retirement plan must maintain a written statement of investment policy. This document provides the fiduciaries with guidelines concerning various categories of investment management decisions. Two of the main issues addressed in the statement are proxies and the activities of the investment manager.

Jill has created a revocable trust to provide for the support of her adult child. The trust has generated $20,000 in income during the year and is invested in a wide variety of stocks and bonds. Which of the following statements concerning this trust is NOT TRUE?

Jill reduces her potential estate tax liability by the amount of the gains in the trust. A revocable trust must be established as a living trust since the donor retains control over the assets. This type of trust does not reduce the donor's potential estate tax liability. With an irrevocable trust, the donor loses control of the assets, but the assets will not be included as part of the donor's estate. This is the trade-off between the two types—retain control and potentially pay more taxes (revocable trust) or lose control and potentially pay less in taxes (irrevocable trust)

Jack purchased 100 shares of XTRO at $20. After nine years, he gave the shares to his nephew Sam when the fair market value of XTRO was $16 per share. Sam held the stock for seven months and then sold the shares for $23 per share. What is the tax consequence for Sam?

Long-term capital gain of $300 If securities are received as a gift, any tax implication is delayed until the securities are subsequently sold. For the recipient, the two details that should be determined are 1) the donor's cost basis and 2) the fair market value (FMV) at the time of the gift. One of these two will represent the recipient's basis for determining a capital gain or loss at the time of sale (referred to as dual basis), as described below: If the securities are later sold for a price that is higher than the donor's cost, the seller's basis is the donor's cost and the donor's holding period is included. If the securities are later sold for a price that is lower than the FMV at the time of receiving the gift, the seller's basis will represent the FMV and the holding period begins on the day after the gift is received. When securities are given as a gift after they had appreciated in value and the recipient subsequently sells them for a gain, the recipient's basis is the lesser of the donor's cost or the fair market value at the time of the gift (i.e., always the donor's cost). However, this is a tricky question since the securities were gifted at a time when the fair market value ($16) is less than the donor's cost ($20). Sam later sold the stock for a price that was higher than Jack's cost. For that reason, Sam will use the $20 cost as his basis against the proceeds of $23 on the sale, which results in a capital gain of $3 per share, or $300. In this situation, Sam is able to add Jack's holding period to his own (nine years plus seven months) to establish a long-term holding period and therefore he realizes a long-term gain.

In determining the loan value of marginable securities, the agent should:

Multiply the market value by 50% The loan value of most marginable securities is determined by multiplying the market value of the securities by Regulation T of the Federal Reserve Board, which is 50%. There is no provision in the Uniform Securities Act that discusses the margin requirement on securities. The percentage is set forth by either the FRB or by certain self-regulatory organizations (SROs) such as the NYSE or FINRA

Which of the following statements is NOT TRUE regarding limited liability companies?

Only a limited number of states permit them Limited liability companies may now be established in any state by filing the appropriate documents with the secretary of state or another state authority. All the other statements are true.

The biggest disadvantage of investing in a growth mutual fund is the potential loss of:

Principal When an individual invests in a mutual fund that consists primarily of common stocks, his principal is at risk. As the market value of the mutual fund fluctuates over the life of the investment, the result may be a loss of the customer's principal or investment.

An IAR is assisting an executor with an account in which the prior owner has died. Who has authority to take action in the account?

The fiduciary of the estate When a person dies with a will, she has named an executor who will act as a fiduciary for the estate. If a person dies without a will, a court will appoint an administrator to act as a fiduciary for the estate. Notice that the question mentions the term "executor," which makes fiduciary the best response. Durable powers of attorney don't remain in effect after a person dies.

Which of the following statements is TRUE regarding the grantor of a trust?

The grantor may be the trustee and/or the beneficiary of a trust if desired The grantor of a trust may be the trustee and/or the beneficiary of a trust.

John and Chris are a married couple in their forties with two children. They have an annual income of $100,000. Their main assets are their house and John's 401(k) plan. They also have approximately $25,000 available for investment. Which of the following choices should the investment adviser representative recommend?

They should give the adviser a list of their investment objectives and goals The investment adviser needs more information about this couple's investment objectives before she can recommend a suitable strategy. All of the investment options could all be appropriate recommendations for this couple depending on their goals.

Which of the following is TRUE regarding the difference between owning property under community property compared to joint tenants with rights of survivorship?

With a community property agreement, when one owner dies the cost basis of all of the assets steps-up to the market value, thereby reducing potential capital gains Community property is a type of joint ownership that's only available to married couples and only in select states. On the other hand, joint tenants with rights of survivorship is available in all states and the joint owners don't need to be married. With both forms of ownership, assets will be transferred to the surviving owner(s) after the death of one owner. With community property, the cost basis of all of the assets is stepped-up after the death of one owner in a manner that's similar to inheriting securities. However, with joint tenants with rights of survivorship, the decedent's portion of the assets are stepped-up, but the surviving owner's assets basis remains the same.

Which of the following statements is TRUE regarding an individual who takes benefits from a retirement account that's been awarded under a QDRO?

Withdrawals can be made without penalty, even if the individual is under the age of 59 1/2. A qualified domestic relations order (QDRO) is created to divide a person's retirement account during a divorce. The spouse who receives benefits awarded under a QRDO is exempt from the early withdrawal penalties, but the withdrawals are taxable. The beneficiary can also roll her portion of the account into an IRA, thereby delaying withdrawals and taxes. QRDOs are used for any ERISA qualified retirement account, including pensions, 403(b) plans, and 401(k) plans.

You have been approached by Steven to provide investment advice. Steven was recently named as executor of his uncle's estate and wants your assistance managing the investment portfolio pending disposition. Which of the following statements is TRUE?

You may accept the assignment You may accept the assignment. The executor is free to obtain any necessary outside advice in the exercise of his fiduciary duty. Permission of the court or heirs is not required. Regarding your advice, remember that the estate will be short-lived and, therefore, your focus should be mainly on safeguarding the assets for the benefit of the heirs. Long-term investments or speculative investments would generally not be suitable.